Pat Sweet

The case [Her Majesty’s Revenue and Customs v Royal Opera House Covent Garden Foundation: [2020] UKUT 132 (TCC)] concerned supplies made by the Royal Opera House (ROH), a charitable theatre whose supply of admission to a theatre event is exempt under the cultural VAT exemption.

The dispute centred on HMRC exercising its powers to override the standard method on the basis that it was not fair and reasonable.

ROH receives exempt income from the sale of tickets for performances as well as taxable income from programme sales, sponsorship income, the sale of ice-creams and the provision of catering in bars and restaurants.

ROH recovered a significant proportion of VAT on production costs on the basis that it considered that there was a direct link between taxable income streams and the production costs.

The rationale for this was that the better the production was, the more people would attend and the greater the income generated by the catering outlets would be.

HMRC’s view was that this resulted in an unfair level of VAT recovery as the production costs were a cost component of the ticket (and programme) sales but not a cost component of catering.

It therefore required ROH to apply the standard method override which resulted in a reduced level of VAT recovery.

A First Tier Tribunal (FTT) considered whether there was a link between certain supplies and the ROH’s production costs for the purposes of determining whether input VAT on production costs could be partially recovered.

At the FTT, the supplies in question were of meals and souvenirs at the theatre (before, during and after the performance) including ice cream sales, shop sales and catering in restaurants.

The FTT agreed that these supplies did create such a link and therefore that an element of the input VAT incurred on the production costs is recoverable.

While HMRC accepted that the production cost had a direct and immediate link to programme sales, production specific sponsorship, shop sales of ROH recordings and production-related venue hire, it made an appeal to the Upper Tribunal against the finding that the production costs had a direct and immediate link to the catering and ice cream sales.

The Upper Tribunal agreed with HMRC that the link between the production costs and the catering supplies was indirect. The production costs were only cost components of the exempt supply of tickets to the performances staged by the ROH and were not cost components of the catering supplies.

The tribunal judges pointed out in their ruling that a costume is used for a ballet performance and a guest opera singer sings at the opera. In both these examples, the production costs are, undeniably, specifically attributable to the ballet and opera performances and are physically used to put on the ballet and opera productions.

The ruling stated: ‘However, the same cannot be said of the catering supplies. The production costs are not used in order to make supplies of champagne at the bars of the ROH.

‘There is an indirect link to the supplies of champagne in that without the performances the champagne would not be served but that is an indirect link.

‘In no sense could it be said that the production costs are part of the costs of supplying the champagne and thus a direct and immediate link is precluded.’

The judges accepted the argument that the catering supplies helped give a visitor to the ROH ‘a fully integrated visitor experience’, they said that is not sufficient in itself to enable conclusion to be reached that the production costs are a cost component of the catering supplies.

The Upper Tribunal stated: ‘This case shows that the requirement of a direct and immediate link between the two supplies is an important qualification which must be satisfied if the input tax is to be deducted.

‘It was always clear that a “but for” test of causation was not sufficient in itself to satisfy the direct and immediate requirement.

‘It is not enough to express the “but for” test in economic terms and then contend that the link must be considered to be direct and immediate.

‘A requirement that the link be direct and immediate will produce the result in some cases that an indirect link or a non-immediate link will not meet the requirement.’

On that basis, the Upper Tribunal concluded HMRC was correct to deny ROH’s claim to recover VAT input tax associated with the production costs.

Alison Hone, partner Saffery Champness, said: ‘It should be remembered that the dispute surrounded an override of the standard method. It was not disputed that production costs related to both exempt and taxable supplies of the ROH, but rather the extent to which production costs related to activities other than the performance.

‘There is no suggestion in the decision that production costs are not non-attributable and theatres should consider how they have treated production costs.

‘Theatres should also consider whether HMRC could argue that the standard, or other partial exemption methods, could be overridden on the basis that it is not fair and reasonable. Generally, the difference in input tax between the standard method and another method needs to be more than £50,000 before HMRC can trigger these provisions.’

Terri Bruce, director of indirect tax for SMEs and not for profits at Midlands-based firm Dains said: ‘The decision has a direct impact on theatres but may have wider ramifications for any partly exempt business or charity as it gives support to HMRC’s argument that input tax is only recoverable where it has a direct and immediate link to, or is a cost component of, taxable supplies made by a business.

‘This is in line with the recent CJEU decision in The University of Cambridge case and the Supreme Court decision in Frank A Smart.

‘Any businesses in similar circumstances should consider whether the decision creates potential exposure regarding current attribution of costs.

‘We recommend that all partly exempt businesses should consider whether existing partial exemption methods could be overridden on the basis that they are not fair and reasonable.’